With Strings AttachedWith Strings Attached

David T. Leibell, Daniel L. Daniels and Russ Alan Prince

Even with the reduction in capital gains taxes and the possibility of a permanent repeal of the estate tax, wealthy individuals are showing increased interest in charitable giving.

This new wave of donors typically wants to retain some say-so over money donated, even after it has been donated. As such, they are increasingly interested in establishing vehicles like donor-advised funds and private foundations, which allow for such ongoing involvement.

This column will discuss five alternatives for donors who fit this mold.

Restricted Gifts

One way for a donor to control how a gift is used is to place restrictions on the gift. The best way to restrict the use of a charitable gift is to have a written contract with the charity. Such a document could state, for example, that the funds must be used to construct a building to be named after the donor. If the building was never built or the name never delivered, the contract could require that the funds be moved to another charity. (It is important to note that in most states the state attorney general — not the donor — is the only one with the authority to sue a charity to enforce the terms of a charitable gift. But this is beginning to change in some places, including New York.)

Private Foundations

Donors seeking the greatest amount of ongoing control should consider establishing their own private foundations. A private foundation is different than a public charity, because it usually receives its funding from one individual or one family. Although private foundations can operate programs, the principal activities of most private foundations lie in making grants to public charities and in awarding scholarships.

If a donor funds a private foundation with cash or with publicly traded marketable securities, the donor will be entitled to an income tax charitable deduction equal to the full fair market value of the property contributed. Deductions for contributions of any other type of assets, such as real estate or closely held business interests, are limited to the cost basis of the property. A private foundation is required to make grants of roughly 5 percent of its assets each year and is subject to onerous excise taxes if it engages in a long list of activities prohibited by the Internal Revenue Code. It is also subject to an annual excise tax on investment income. Given the administrative costs of establishing and administering a private foundation, the value of the foundation should be at least $500,000.

Donor-advised Funds

A donor-advised fund is basically a poor man's private foundation. Donor-advised funds are a type of public charity sponsored by community foundations and commercial gift funds (e.g., Fidelity Charitable Gift Fund). A donor can open an account with the sponsoring charity. Minimum account size is usually between $10,000 and $50,000. As the donor-advisor for the account, the donor has the right to make nonbinding recommendations to the charity operating the fund regarding the grants made from the donor's account. Sponsoring charities generally give full and careful consideration to their donor-advisor's wishes but are not legally bound by them. The donor has the right to name successor donor-advisors for the account. As long as the charity operating the fund is a public charity, the donor's contributions will be treated more favorably for purposes of the income tax charitable deduction than a contribution to a grant-making private foundation would be, and the private foundation excise tax rules will not apply.

Supporting Organizations

If a donor intends to make grants to a particular public charity or charities, then the donor may want to create a supporting organization instead of a private foundation. A supporting organization is organized and operated exclusively to benefit certain identified public charities. It is, itself, classified as a public charity, rather than as a private foundation, because of its relationship with and responsiveness to the public charities it was created to support, and because it is not controlled, directly or indirectly, by the persons who create and fund it or their family members. Since a supporting organization is a public charity, contributions it receives qualify for more favorable treatment under the income tax charitable deduction rules. In addition, the onerous excise tax rules discussed above that apply to private foundations do not apply to supporting organizations.

However, the organizational and operational requirements for a supporting organization can be as or more cumbersome to deal with than the private foundation excise tax rules.

There are two types of supporting organizations available to donors, one that is controlled by one or more supported public charities (Type I) and one that is controlled by “independent” persons (Type III). Type III supporting organizations have been marketed in recent years as private foundation alternatives without the burdensome private foundation restrictions.

Winklevoss Donor-Managed Investment Account Program

The IRS has approved a charitable-giving strategy in which donors can manage the investments of their charitable contributions after the funds have been gifted to charity. The Donor Managed Investment Account Program (DMI) is a proprietary program developed by Winklevoss Consultants, which has filed a patent application for the strategy.

Unlike a donor-advised fund, which limits investment alternatives to a few specific mutual funds or predetermined investment strategies, the DMI account program allows a donor (or his or her financial advisor) to choose among a wide variety of investment alternatives. Although there is more investment flexibility for a DMI account, the strategy may be less flexible than a donor-advised fund with respect to distributions from the account. Funds in a DMI account are owned by the recipient charity. The donor is granted authorization by the recipient charity to direct the investment management of the funds in the DMI account for an agreed-upon period of time by the recipient charity. During that time, the donor can actively reallocate the investments at any time, either on his or her own or with the help of an investment advisor. At the conclusion of the agreed-upon investment management period, the funds in the DMI account are applied to the agreed-upon use established by the donor and the recipient charity in the DMI account agreement.

As you can see, for the donor who wants to stay involved with a donation, the array of alternatives is a large one. Although the private foundation is still the gold standard for any donor who wants to retain maximum control, advisors should remember the other alternatives, which all offer moderate to significant donor control, but with tax benefits and cost structures that are better than those available through a private foundation.